Citigroup Fed hike trades put Russell 2000 options in focus
Citigroup strategists say Russell 2000 ETF puts may help investors hedge a hawkish Fed surprise as markets wait on rates and megacap earnings.
By Sal Moretti · Money Reporter
3 min read
Citigroup Fed hike trades are getting fresh attention as Wall Street heads into a Federal Reserve meeting with a surprise rate increase no longer looking like a fringe worry.
A team of Citigroup strategists led by Stuart Kaiser, the bank’s head of U.S. equity trading strategy, told clients that investors concerned about a rate increase or a more hawkish Fed should consider buying put options on the iShares Russell 2000 ETF, known by its ticker IWM.
MarketWatch reported that the perceived chance of a Fed rate hike this week had risen to 31% from a week earlier after a jump in oil prices. Citi said there was no clear consensus for the July meeting, but warned that a hawkish outcome would pose a risk for stocks.
What trade does Citigroup like for a Fed hike?
Citi’s preferred hedge is buying puts on IWM, the exchange-traded fund tied to the small-cap Russell 2000 index. A put option gives its buyer the right to sell an asset at a set price during a specific period, and investors often use puts when they want protection against a drop.
Kaiser’s team said IWM may now react more sharply to economic reports and Fed decisions because the Russell 2000 has lower exposure to growth and momentum stocks after its June rebalance. In their note, they said a more data-dependent Federal Open Market Committee could make the small-cap fund behave more cyclically than it has in recent years.
The strategists said the Russell 2000 had become unusually tilted toward growth and price momentum names over the past two years, making it more responsive to rates and credit spreads than to economic data. The rebalance, in Citi’s view, has corrected some of those distortions.
That shift also made the options trade cheaper, according to the strategists. Citi said the average three-month implied volatility for the 10 largest Russell 2000 stocks has fallen to 56% from 90%, while realized volatility over the past month was a little above 48%.
Across Russell 2000 member stocks, the strategists said index-weighted realized volatility had declined by about five points over the past three months. Lower volatility can reduce the cost of options, which is why Citi sees the IWM put trade as a more attractive hedge now.
Why the Fed meeting has Wall Street on edge
The Fed meeting lands during a packed week for markets. Investors are waiting for earnings from Meta, Microsoft, Amazon and Apple, with attention on what those companies say about artificial-intelligence spending.
MarketWatch reported that U.S. stock futures were rising and Treasury yields were falling early Monday after oil prices sank. The move in oil came as the U.S. and Iran paused hostilities, raising hopes for another round of negotiations.
Citi said even if the Fed leaves rates unchanged in July, markets may not get much relief because the odds of a September increase are above 70%. The strategists also noted that Fed Chairman Kevin Warsh has promised less guidance about rate intentions, which could leave investors more focused on incoming data and the next policy meeting.
The Citi team said it remains positive on stocks through at least month-end, but urged caution. After megacap earnings, the strategists expect equities to become more sensitive to higher yields, rising oil prices and new equity supply ahead of a seasonally weaker stretch.
Beyond the Fed hedge, Citi said it preferred materials, banks, the Nasdaq-100 tracking ETF QQQ and its basket of AI power-generation stocks. The strategists also said early earnings season has been stronger, though the average stock has still slipped on the day it reports.
This story draws on original reporting from MarketWatch.